International Accounting Standard (IAS) 17 relates to leases and governs the way that they are accounted for in the financial statements of lessees and lessors. As many in the accounting and finance industries will know, IAS 17 is in the process of being updated. Exposure Draft 332 was issued on 16 May 2013 and is expected to become effective in late 2013.
Jacques de Klerk, Director at RentWorks, explains that this is causing much concern among accountants and financial directors as it means companies will have to change the way they account for assets that they rent, which has an effect on their financial statements and can affect their credit ratings. “We’re seeing some companies deciding against renting assets because they’re worried about the changes that the update to IAS 17 will force on them,” he says. “While it will be a once-off adjustment in companies’ accounts, I still firmly believe that the benefits of rental versus cash will apply.”
Previously, leases were classified as operating or financing leases. The deciding factors in determining whether a lease would be classified as the former or the latter were whether ownership would pass to the lessee at any stage. For example, in the case of a building lease, the lessee would rent the building for a set length of time without taking ownership of the building. In this case, it would be considered an operating lease and was allowed as an off-balance-sheet financing option.
On the other hand, a finance lease would be when ownership of an asset passes to the lessee at the end of the term, for example in the case of an individual who finances his car purchase through the bank, where the vehicle essentially belongs to the bank until he has finished paying his monthly instalments over a fixed term, at which point the car becomes his property. In this case, the asset and liability were to be recognised and accounted for under IAS 17.
If the amendment of the updated IAS 17 comes into play, all leases will be capitalised (in a new way) and there will be no more straight-lining of lease payments. The previous operating lease treatment will only be applicable where the maximum term of lease is 12 months or less (including the option to renew). Leases will be classified by the lessor and lessee using the same principle and the lessee will be required to recognise the asset and liability (whereas the lessor is not).
Essentially, De Klerk explains, the new system is based on “right of use” and not the “right to control use”. Lessees will have to recognise the “right of use” asset for the right to use the leased asset and a “lease liability” for the obligation to make rental payments over the lease period.
Instead of being divided into operating and finance leases, leases will now simply be termed Type A (assets that are not property) and Type B (property leases).
De Klerk admits that these changes will be a headache upfront for accounting departments, but believes that there will also be unexpected benefits for lessees. “This is going to force rental providers to offer more innovative products and services to their clients,” he says. “We’ll have to start looking at more flexible rental packages with shorter terms and designing attractive service agreements. We will have to continue to adjust to smooth the implications of the new regulations for our clients. It’s also going to weed out non-quality players in the rental industry who are not equipped to provide companies with the information that they will need to make the necessary accounting changes.”
De Klerk notes that regulations have changed before and will change again, but that the fundamental benefits of rental remain the same. “Although companies won’t be able to avoid disclosing the rental of assets on their books any longer, it’s really a once-off adjustment that will then become the new set norm,” he says. “They’ll still get the benefits of renting. The accounting is the only thing that will change.”
De Klerk cites improved cash-flow, avoiding technology obsolescence and lower Total Cost of Operation (TCO), especially with more stringent e-waste laws coming into play, as just a few of the benefits of rental that he believes will prompt businesses to continue to choose rental over cash, despite the accounting changes.
“Companies should just ensure that they are dealing with responsible rental financer who understands the accounting changes and is able to provide the client with the necessary information to capitalise and manage the assets properly,” he concludes. “The rental industry will need to ride this wave, ensure that we embrace the changes and keep trying to offer our clients the best possible solutions for their businesses.”